Option Pricing under Unknown Volatility: An Agent-Based Modeling and Simulation Approach

We modeled an artificial European option market with unknown volatility using an agent-based modeling and simulation approach. Contrary to the standard Black and Scholes model with "known" volatility, there is significant pricing bias (market price/theoretical price) in the presence of unk...

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Bibliographic Details
Main Authors: Shu Lin Zhang, De Yu Feng, Shu Ping Wang
Format: Conference Proceeding
Language:English
Subjects:
agent-based simulation
Bayesian methods
Context modeling
disequilibrium model
Educational institutions
Equations
Instruments
Measurement uncertainty
Mechanical factors
option pricing
Parameter estimation
Pricing
Security
unknown volatility
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Summary:We modeled an artificial European option market with unknown volatility using an agent-based modeling and simulation approach. Contrary to the standard Black and Scholes model with "known" volatility, there is significant pricing bias (market price/theoretical price) in the presence of unknown volatility. Moreover, the unknown drift has a significant nonlinear effect in the pricing bias. Finally, pricing bias tends to decrease as the drift increasing in the case of low volatility. Our approach may serve as a first step towards the goal of option pricing in disequilibrium with unknown volatility.
DOI:10.1109/ICIFE.2009.25